California Court Holds that Kruger v. Wells Fargo Bank does not Apply to Offsets of Government Benefits Against Overdraft and Other Fees Incurred in Connection with the Same Deposit Account

Plaintiff filed a class action in California state court against Bank of America alleging inter alia violations of the state’s Consumer Legal Remedies Act (CLRA) and Unfair Competition Law (UCL) arising out of the bank’s use of Social Security disability benefits directly deposited into a Bank of America checking account to offset overdraft charges. Miller v. Bank of America, NT & SA, 144 Cal.App.4th 1301 (Cal.App. November 20, 2006) [Slip Opn., at 1-2]. Defense attorneys argued that banks may lawfully apply government benefit deposits against overdraft and other fees connected with the same account. The trial court, however, agreed with plaintiff’s lawyer that Kruger v. Wells Fargo Bank, 11 Cal.3d 352 (Cal. 1974), which held that banks may not use public benefit funds deposited in one bank account to offset “an account holder’s delinquent but separate credit card account,” bars banks from using government benefits to offset any funds owed the bank. Id. The California Court of Appeal framed the issue as follows: “Does a bank act illegally if when balancing customer accounts, it credits for Social Security benefits and other public benefit payments directly deposited to its customers’ checking accounts to cover debits for overdraft and overdraft fees?” Id. In reversing the trial court, the appellate court summarized its holding as follows: “In this case, the trial court applied Kruger to prohibit [the Bank] from collecting for overdrafts and fees by debiting directly deposited Social Security and other public benefit payments. This application of Kruger is an extension of its holding that is unwarranted in light of significant differences between the banker’s setoff addressed in Kruger and the facts of this case.” Id.

The case arose from a bank error in posting an $1800 credit to plaintiff’s account. The bank discovered its error and reversed the credit, causing plaintiff’s account to be substantially overdrawn. After a Social Security payment was deposited directly into plaintiff’s checking account, “it was automatically balanced against the larger overdraft to reduce his negative balance.” Miller, at *1-*2. When plaintiff complained the bank reversed the debit. Future direct deposits from Social Security that the bank credited against the overdraft balance were also reversed when plaintiff complained. Id., at *2. Plaintiff filed his class action lawsuit against the bank alleging numerous causes of action including intentional and negligent misrepresentation, intentional infliction of emotional distress, unlawful levy of Social Security benefits, and violations of California’s CLRA, UCL and False Advertising Act (FAA). The trial court granted summary adjudication in favor of the defense on the intentional infliction of emotional distress and unlawful levy claims, but the remaining causes of action proceeded to trial. Id. It certified a class consisting of more than 1 million members defined as California residents with “a checking or savings deposit account with Bank of America into which payments of Social Security benefits or other public benefits are or have been directly deposited by the government or its agent.” Id., at *3.

At trial, the bank did not deny using government benefit funds directly deposited into customer checking accounts to offset overdraft and other fees incurred in connection with that account. In fact, trial testimony established that “all banks clear negative checking account balances from incoming deposits to those accounts irrespective of their source, including deposits of government benefits.” Miller, at *3. The evidence also established that if banks were not permitted to do this then they “would have to impose numerous restrictions on accounts containing government benefits to prevent them from becoming overdrawn.” Id., at *4. The trial court essentially instructed the jury to enter judgment against the bank as it gave the following instruction:

Governmental benefits, including Social Security funds, are exempt from collection by the bank for insufficient funds fees [], overdrafts and money claims it has against the account holders. This action by the Bank is called a set-off. Funds from other sources are not exempt under this procedure.

Id. Not surprisingly, then, the jury found in favor of plaintiff and awarded $75 million in damages plus $1000 for each of the more than one million class members. Id., at *4-*5. Separately, the trial court ruled in favor of plaintiff on the non-jury claims, id., at *5, and awarded almost $300 million in damages, id., at *6. “On all counts, the court’s decision turned on the interpretation that Kruger prohibits banks from clearing overdrafts and NSF fees, or recovering any ‘other monetary claims,’ from directly deposited benefit funds.” Id., at *5 (footnote omitted). (The trial court also entered an injunction against the bank, but in light of the appellate court’s reversal of the judgment we do not discuss its terms or its inherent ambiguities.)

The Court of Appeal began its analysis by observing that the judgment against the bank “turn[s] entirely on the court’s determination that Kruger prohibits the Bank from clearing overdrafts and debiting NSF fees or other money claims in a deposit account when the credits against those charges are from government benefits directly deposited into that same account.” Miller, at *7. This interpretation of Kruger was based “upon the broadly worded holding of Kruger that ‘a bank may not exercise its right of setoff against deposits which, derived from unemployment and disability benefits, are protected from the claims of creditors.'” Id. (quoting Kruger, at 356). The appellate court proceeded to analyze Kruger in detail, id., at *7 et seq., and concluded that critical differences between exist that compel a contrary holding in this case. One of these differences is that Miller did not involve an attempt by the bank to collect a third party debt, id., at *9. Another difference is that the offsets were applied to the same account, which the Court of Appeal held was important because “Collecting a debt unrelated to the bank account, such as a credit car debt, does not implicate the internal balance of a single bank account.” Id., at *10. Further, to otherwise account for these risks would require substantial and adverse consequences to depositors of government benefits, id., at *13.

In the end, the appellate court refused to extend Kruger beyond its facts, and found worth nothing that “in the 30 plus years since Kruger was decided, no other court, until now, has construed Kruger to apply to the management of debits and credits within a single account.” Miller, at *14.

NOTE: The United States Treasury Department weighed in on the side of the bank, expressing concerns that the judgment “would likely cause banks to reduce the range of services available to recipients of government benefits in order to minimize the risk of overdrafts, or cause higher prices for such services, working a significant detriment on both the plaintiff class and the general public interest.” Miller, at *13.

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About the Author

Michael J. Hassen

Michael J. Hassen's litigation practice spans almost 30 years and emphasizes general business and commercial litigation, including class action defense and unfair business practice representative actions (section 17200).

He represents lenders in all facets of lender litigation, ranging from class actions and unfair business practices based on alleged "predatory" lending and RESPA violations or alleged violations of the Fair Debt Collection Practices Act, to claims alleging elder abuse or challenging the validity or priority of liens.

Michael also has significant experience in business torts such as misappropriation of trade secrets and raiding of corporate employees, ADA claims, and all phases of commercial and real estate finance, construction finance and construction defect claims.

He is experienced in appellate matters, having had primary responsibility for preparing more than 100 appellate briefs.